China’s economy is slowing down and the Chinese Stock Market is about to crash. What does this mean for the rest of the world?

What’s so special about China’s economy?

Economy; “the state of a country in terms of the production and consumption of goods and services and the supply of money within the country”

So a strong economy is one which grows at a stable rate, increasing the amount of money in the country. A weak economy is one that is unstable and may shrink, decreasing the amount of money in the country.

The Chinese economy is made up of a vast amount of goods and services – just think how many technological goods, clothing and cars are produced in China. China has a population of around 1.3 billion people andChinese labour costs are exceedingly low. These factors make China’s economy the second largest in the world (the USA is the largest).

For the past few decades the Chinese economy has been steadily growing by around 10% each year. That all changed this summer. Economic growth slowed down and the Chinese Stock Market saw a massive drop in value.

Chinese Economy Explained: China makes most of its money from exporting good to other countries

The Chinese economy relies on investment from other countries. This is because it’s economic model is based on exports. This means selling goods and services to other countries.

China is the largest exporter of goods in the world. The export model means the majority of Chinese goods are exported to other countries, rather than being consumed and used within China itself.

This doesn’t mean that goods made in the country can’t be sold to the Chinese people, but for the moment most companies are focusing on selling abroad.China’s top export products include computers, telephones and office equipment. Last year China’s exports were valued at $2.34 trillion. Wowzers.

Like China, other Asian countries like Japan, Thailand, Indonesia and South Korea use the export model to make money and increase living standards. Nevertheless there is and was a catch: the model is not sustainable.

“Not sustainable”

The Export model made China one of the leading economies in the world. It aims to bring money into the country by industrialising. For China this meant encouraging investors to build factories and transport links in order to build and sell even more products.

China encouraged foreign investment from other countries by establishing “special economic zones” in the 1980s. These zones are areas in the country with special tax benefits for foreign investors. Offering lower tax rates to companies means they are more likely to set up shop in the country.

Chinese Economy Explained: China invested in building lots of factories but the recession meant other countries bought less Chinese exports

Foreign investment means more money coming into the country. China’s low wages means manufacturing costs are kept low, meaning more profit for businesses. However, as the China Business Review notes, it didn’t matter how cheaply China could make things as “developed economy demand for manufactured products cannot increase without limit”

In plain English: eventually there will be a limit to what other countries can afford to buy from China.

The Economist agrees that the model is “only a part of the answer to establishing a sustainable economy”.

Economic strategist Patrick Chovanec explained to the Washington Post how “after the financial crisis in 2008, there were signs that… other countries could not afford to go deeper into debt to consume that much. So you started to see a significant falloff in Chinese exports”.

Meaning: China’s exports were dropping, as countries couldn’t afford to buy as many Chinese goods. Given the Chinese economy depends on exporting to other countries; this was a big problem.

Chinese Economy Explained:

2) The Chinese Government has a plan; apparently it’s problematic

To understand Chinese government’s plan to boost the economy we need get our heads around the Stock Market. Don’t panic if you didn’t study business (we didn’t either).

The Stock Market works like this:

Businesses need money in order to expand and grow. To raise this money quickly the bosses sell off part of the company.

One way of doing this is to sell shares in the company. A share is literally a share in the ownership of the said company. The more shares you have, the more of the company you own.

Think: Dragon’s Den (Shark Tank if you’re American).

Investors buy into the company by purchasing shares. The company uses the cash they receive to grow and expand. Investors hope that the value of the company will increase. If it does their shares (the part of the company they own) also become more valuable.

This is sometimes called owning Equity or Stock in a company.

Shares are bought and sold on Stock Markets. Some, like the New York Stock Exchange, are actual locations where stock traders meet to buy and sell. Others, like the Nasdaq, are virtual market-places where traders complete deals via computer.

Now within the context of the Chinese Economy?

Chinese Economy Explained: shares in companies are sold on the Stock Market

After the Global Financial Crisis China’s economic growth began to slow. Within a few years the growth had dropped from 10% to around 7%. This seems like a small change but it was not good news for China.

The Chinese government wanted to boost economic growth. One of their ideas was to change the rules of the Chinese Stock Market. For the first time many ordinary Chinese citizens could buy shares in companies.

Chinese government thinks: more local investment = bigger economic growth.

Government-owned media (newspapers, TV, radio) encouraged people to invest. Many Chinese families borrowed money to buy shares, or invested their savings. They hoped that their shares would eventually grow in value. Between 2014 and 2015 more than 40 million new stock market accounts were opened. However, many of these new investors had no understanding of the financial market. Doesn’t exactly sound like a recipe for success.

Chinese Stock Market Explained: millions of new investors pushed up the price of shares by investing borrowed money

As millions of new investors started placing borrowed money into the stock market, share prices were pushed up to inflated levels.The Chinese government realised that allowing people to buy all these shares with borrowed money was a bad idea.First, if people ended up losing money by making a bad investment then they would then owe a lot of money. Second, these inflated prices were bound to drop at some point.When they eventually did, investors panicked and sold off their shares to pay back the money they had borrowed.

This mass selling pushed share prices down even further and in June 2015 the market crashed downwards. The equivalent of $3 trillion was lost as a result of the drop in share prices. Not a good day to be in finance.

The government tried to encourage business by reducing the value of the Chinese currency, the Yuan. This was meant to make Chinese goods cheaper, encouraging other countries to buy them. So far it hasn’t worked. Investors around the world still fear the problems in the Chinese economy will spread abroad. This isn’t just paranoia BTW; it could actually happen.

Chinese Economy Explained:
3) The Chinese Economy affects the rest of the world

Problems in the Chinese economy have an effect on the London Stock Market

At the moment only 1.5% of Chinese shares belong to foreigners. Despite this fact, the slowing of growth in the Chinese economy and their recent stock market crashes are affecting financial markets in the UK, Europe and America. Put simply: when the Chinese economy goes a bit wobbly, we all feel the effects. Yes, “wobbly” is a technical term.

The BBC reports how stock markets in London, New York and Paris are also seeing drops in value. The value of the FTSE 100 (the UK’s top 100 companies) dropped by around 5% – the largest fall in value this year. These British companies lost the equivalent of £60 billion as a direct result of China’s economic problems.

To recap: there is strong evidence to suggest that China’s export model isn’t working. Economists argue China needs to switch to an economic model called Domestic Consumption (whoever said economics wasn’t sexy?!). In this model goods and services created in the country are bought and used within China.

To achieve this the Chinese government needs to encourage Chinese people to consume more. For example; they attempted to increase the number of washing machines sold to Chinese people in rural communities by distributing coupons and offering a discount.

We’ll have to wait to see if the issues in the Chinese economy lead to trouble around the world. But things don’t look good.

Chinese Economy Lessons; to make money from exports you need someone to export to.